Brasilia divided as central banker spoils auction

Staff Writer
Columbus CEO

(c) 2013, Bloomberg News.

SAO PAULO, Brazil — In one fell swoop, Brazilian central bank director Carlos Hamilton spoiled a Treasury bond auction, contradicted the government's view on inflation and sparked a surge in the nation's borrowing costs.

The 49-year-old official said Aug. 12 that price increases will quicken this month as a slump in the real deepens, causing yields on five-year fixed-rate notes to jump 0.86 percentage point last week to a record high 11.74 percent. That's four times the average 0.18 percentage point rise for local-currency emerging-market sovereign bonds tracked by JPMorgan Chase & Co. The comments prompted Treasury officials to reject all bids in an auction for linkers due 2018 and 2040.

Hamilton's remarks came just three days after President Dilma Rousseff said inflation was under control, underscoring the divergence in monetary and fiscal policies that's undermined Brazil's credibility with bondholders, according to ING Groep NV. While the central bank carries out the biggest interest-rate increases in the world to rein in inflation that rose to an 20- month high in June and support the real, Rousseff prompted state banks to boost lending to six times the rate of privately owned lenders in the first half to revive the economy.

"The central bank is trying to control inflation without help from fiscal policy, and the currency doesn't help either," Marco Freire, who oversees 3 billion reais ($1.3 billion) as chief investment officer at Franklin Templeton Investimentos, said by telephone from Sao Paulo. "We'd like to buy fixed-rate bonds again but we are waiting for a bigger compensation for the risk."

The Finance Ministry and the central bank declined to comment.

The central bank, led by President Alexandre Tombini, raised the target rate by a half-percentage point on July 10 to 8.5 percent, increasing it by 1.25 percentage points from a record low 7.25 percent in April.

Annual inflation slowed to 6.27 percent in July from 6.7 percent in June, according to the national statistics agency. The central bank targets annual price increases of 4.5 percent, plus or minus 2 percentage points.

The real has lost 15 percent in the past three months, the most among major emerging-market currencies.

Hamilton, speaking at an event in Belem, also said that Brazilian fiscal policy has been expansionary, contradicting Finance Minister Guido Mantega's comments to Veja magazine this month that it has been "neutral."

Speaking in Brasilia on Aug. 7, Mantega said July's inflation figures showed that price increases were always under control. The government, which cut spending for the second time in two months last month to help meet its fiscal target, is reducing expenditures by 10 billion reais, Mantega said July 22.

The benefit of spending cuts is being outweighed by other measures designed to stimulate the economy, said Gustavo Rangel, the chief Latin America economist at ING.

"There is this inconsistency in policies when you have the central bank tightening and the Finance Ministry loosening policy," Rangel said in a telephone interview from London. "It obviously hurts credibility. That reinforces pessimism toward Brazil and it hurts the currency as well."

Diego Donadio, a Latin America strategist at Banco BNP Paribas Brasil SA, said the prospect of reduced stimulus from the Federal Reserve that has buoyed emerging-market assets is having a bigger impact on rate expectations in Brazil than Hamilton's comments.

"It's wrong to view this as all because of Hamilton — you have to look at it within a broader context," he said. "There is a global environment of interest-rate adjustment."

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries dropped four basis points, or 0.04 percentage point, to 233 basis points at 6:32 a.m. in New York, according to JPMorgan Chase & Co.

Brazil's five-year credit-default swaps, contracts protecting holders of the nation's debt against non-payment, rose five basis points to 208 basis points. The real lost 5 percent last week to 2.3925 per dollar, a four-year low.

Traders are adding to bets the central bank will raise rates by 0.5 percentage point in October, swaps trading shows.

"The market is going to continue to be volatile," Franklin Templeton's Freire said. "The currency is impacting things, and the government continues to not help with fiscal policy."